International & Emerging Markets Investing

Why Invest Internationally?

International investing means purchasing securities issued by companies or governments outside your home country. For U.S.-based investors, this includes stocks and bonds from developed markets like Europe, Japan, and Australia, as well as emerging markets such as China, India, Brazil, and dozens of other countries.

The case for international investing rests on several fundamental principles. First, the United States represents approximately 60% of global stock market capitalization, which means that investors who hold only U.S. stocks are ignoring roughly 40% of the world's investable opportunities. Some of the largest and most profitable companies in the world are headquartered outside the United States, and many of the fastest-growing economies are in developing regions.

Second, international diversification can reduce portfolio volatility. Different countries' stock markets do not move in perfect lockstep. Economic cycles, monetary policies, political environments, and currency movements create conditions where international markets may perform well when U.S. markets struggle, and vice versa. By holding a mix of domestic and international investments, you smooth out the overall ups and downs of your portfolio.

Third, international investing provides exposure to different structural growth drivers. Emerging market economies often have younger populations, rising middle classes, and accelerating urbanization, factors that can drive economic growth rates well above those of mature developed economies. While higher growth does not automatically translate into higher stock returns, it does create a broader opportunity set for investors.

Developed vs. Emerging Markets

International markets are broadly divided into developed markets and emerging markets, with a smaller third category called frontier markets. Each category has distinct characteristics, risk profiles, and return potential.

Feature	Developed Markets	Emerging Markets
Examples	UK, Japan, Germany, France, Canada, Australia, Switzerland	China, India, Brazil, Taiwan, South Korea, Mexico, South Africa
Economic Maturity	High GDP per capita, stable growth	Lower GDP per capita, higher growth potential
Market Infrastructure	Well-established exchanges, strong regulation, high liquidity	Developing exchanges, evolving regulation, variable liquidity
Political Stability	Generally stable democratic institutions	Variable, may include political and regulatory uncertainty
Currency Stability	Major reserve currencies (EUR, GBP, JPY, CHF)	More volatile currencies, potential for devaluation
Average Volatility	Moderate, similar to U.S. markets	Higher, with larger drawdowns and recoveries
Typical Valuation	Higher price-to-earnings ratios	Lower price-to-earnings ratios (value opportunity or value trap)
Dividend Yields	Generally higher than U.S., varies by country	Variable, can be high but less consistent
Correlation with U.S.	High but not perfect (0.7-0.9)	Lower correlation (0.5-0.8), better diversification

Frontier markets are a subset of emerging markets at an even earlier stage of development. These include countries like Vietnam, Nigeria, Bangladesh, and Kenya. Frontier markets offer the highest potential growth but also the highest risks, including limited liquidity, weak legal protections, and political instability. Most individual investors access frontier markets through specialized funds rather than direct investment.

Ways to Invest Internationally

U.S.-based investors have several practical methods for gaining international exposure, each with different levels of convenience, cost, and risk.

International ETFs and Index Funds

Exchange-traded funds (ETFs) and index mutual funds are the most popular and cost-effective way for most investors to access international markets. These funds hold hundreds or thousands of international stocks in a single vehicle, providing instant diversification across countries and sectors. Popular categories include total international stock market funds, developed market funds, emerging market funds, and single-country or regional funds.

Broad international index funds typically track indices such as the MSCI EAFE (developed markets excluding the U.S. and Canada), MSCI Emerging Markets, or the FTSE All-World ex-US. Expense ratios for broad international index ETFs range from 0.04% to 0.15%, making them accessible and affordable.

American Depositary Receipts (ADRs)

ADRs are certificates issued by U.S. banks that represent shares of a foreign company. They trade on U.S. stock exchanges in U.S. dollars during regular U.S. market hours, making it as easy to buy shares of a foreign company as it is to buy a domestic stock. Each ADR represents a specific number of shares of the underlying foreign company.

ADRs are available for thousands of large international companies including Nestle, Toyota, Samsung (via Korean depository receipts), Taiwan Semiconductor, and many others. They come in three levels: Level 1 ADRs trade over-the-counter with minimal SEC reporting; Level 2 ADRs trade on major exchanges like the NYSE or NASDAQ; and Level 3 ADRs are used by foreign companies issuing new shares to U.S. investors. Level 2 and Level 3 ADRs have the highest transparency and regulatory requirements.

International Mutual Funds

Actively managed international mutual funds employ portfolio managers who research and select international stocks with the goal of outperforming a benchmark index. These funds can focus on specific regions (European funds, Asian funds), market capitalization ranges (international small-cap), or investment styles (international value, international growth). Expense ratios are higher than index funds, typically 0.50% to 1.50%, and the evidence suggests that most active international managers underperform their benchmarks over long periods, similar to the U.S. market.

Direct Foreign Stock Purchases

Some brokerages allow you to buy stocks directly on foreign exchanges. This provides access to the full universe of international companies, including smaller firms not available as ADRs. However, direct foreign investment involves foreign currency transactions, different settlement times, higher trading costs, and potential complications with foreign tax withholding. This approach is typically used by experienced investors with specific investment theses about individual foreign companies.

Currency Risk

Currency risk (also called exchange rate risk) is the risk that changes in the value of foreign currencies relative to the U.S. dollar will affect the returns of your international investments. When you invest in a foreign stock, your return depends on both the performance of the stock in its local currency and the change in the exchange rate between that currency and the U.S. dollar.

For example, if a European stock rises 10% in euro terms but the euro falls 5% against the dollar during the same period, your return in U.S. dollar terms is approximately 5% (the stock return minus the currency loss). Conversely, if the euro strengthens against the dollar, your returns are amplified.

Currency movements can be significant. Over short periods, currency fluctuations can add or subtract several percentage points of return. Over longer periods, currency effects tend to average out somewhat, but they remain an important source of both risk and return for international investors.

Country Risk

Country risk encompasses the political, economic, and regulatory risks specific to investing in a particular nation. While developed markets generally have lower country risk, even they are not immune to political upheaval, regulatory changes, or economic crises. Emerging markets tend to have higher country risk across multiple dimensions.

• Political risk: Changes in government, political instability, nationalization of assets, restrictions on foreign investment, and geopolitical conflicts can all negatively impact investments. Sanctions, trade wars, and diplomatic tensions between countries can affect specific markets or companies.
• Regulatory risk: Changes in tax policy, foreign ownership rules, capital controls (restrictions on moving money out of a country), and industry-specific regulations can reduce the value of international investments. Some emerging market governments have unexpectedly imposed restrictions on foreign investors.
• Economic risk: Inflation, sovereign debt crises, banking system failures, and severe recessions can devastate local stock and bond markets. Countries with high debt levels, current account deficits, or dependence on commodity exports are particularly vulnerable.
• Legal and governance risk: Weak rule of law, corruption, inadequate shareholder protections, unreliable financial reporting, and limited recourse for investors can make it difficult to protect your investment rights. Corporate governance standards vary significantly across countries.

Diversification across many countries is the primary defense against country risk. A broad international index fund that holds stocks from 20 or more countries is far less vulnerable to any single country's problems than a concentrated bet on one or two nations.

Geographic Diversification Benefits

The primary benefit of geographic diversification is reducing the risk that your portfolio is overly dependent on the economic fortunes of a single country. While the U.S. market has outperformed most international markets over the past decade, this has not always been the case and is not guaranteed to continue.

From 2000 to 2009, often called the "lost decade" for U.S. stocks, the S&P 500 delivered a total return of roughly negative 9%. During that same period, international developed markets and emerging markets both delivered positive returns. Investors who held a globally diversified portfolio fared significantly better than those who held only U.S. stocks.

Market leadership rotates over time. In the 1970s, 1980s, and 2000s, international markets outperformed the United States. In the 1990s, 2010s, and early 2020s, the United States led. Predicting which region will outperform in the next decade is extremely difficult, which is precisely why holding both domestic and international investments makes sense. A globally diversified portfolio ensures you participate in whichever region leads, without needing to predict it in advance.

Most financial planners and investment professionals suggest an international allocation of 20% to 40% of your total stock portfolio, depending on your risk tolerance, tax situation, and investment horizon. Some follow a market-capitalization approach, allocating roughly 40% internationally (reflecting the non-U.S. share of global market cap), while others use a lower allocation due to the natural international revenue exposure of large U.S. multinational companies.

Popular International Indices

Understanding the major international indices helps you evaluate international funds and benchmark your international portfolio performance.

MSCI EAFE Index

The MSCI EAFE (Europe, Australasia, and Far East) index is the most widely used benchmark for international developed market stocks. It covers approximately 800 large- and mid-cap stocks across 21 developed markets, excluding the United States and Canada. The largest country weights are typically Japan, the United Kingdom, France, Switzerland, and Germany. Numerous ETFs and mutual funds track this index, making it easy and inexpensive to gain broad developed market exposure.

MSCI Emerging Markets Index

The MSCI Emerging Markets index covers approximately 1,400 large- and mid-cap stocks across 24 emerging market countries. China, India, Taiwan, South Korea, and Brazil typically represent the largest weights. This index has higher volatility than the EAFE but has delivered higher long-term returns during periods of strong emerging market growth. It is the standard benchmark for emerging market equity funds.

FTSE All-World ex-US Index

The FTSE All-World ex-US index is a comprehensive benchmark covering both developed and emerging market stocks outside the United States. It includes approximately 3,500 stocks across more than 40 countries. This index is used by total international stock market funds that combine developed and emerging market exposure in a single holding, such as the Vanguard Total International Stock ETF (VXUS).

MSCI ACWI ex-US

The MSCI All Country World Index ex-US (ACWI ex-US) is similar to the FTSE All-World ex-US but uses MSCI's country classification methodology. It includes both developed and emerging markets and serves as a benchmark for total international portfolios. The key difference between MSCI and FTSE classifications is that South Korea is classified as an emerging market by MSCI but as a developed market by FTSE.

Home Bias and How to Overcome It

Home bias is the tendency of investors to overweight their portfolio in domestic securities relative to what would be optimal based on global market capitalization. Studies consistently show that investors around the world, not just in the United States, allocate a disproportionately large share of their portfolios to their home country. U.S. investors hold approximately 75% to 80% of their equity portfolios in U.S. stocks, despite the U.S. representing roughly 60% of global market capitalization.

Home bias persists for several understandable reasons. Investors are more familiar with domestic companies and brands. Domestic investments do not carry currency risk. Tax treatment is simpler. Financial media coverage focuses on domestic markets. There is a natural comfort in investing in what you know. However, these reasons are psychological and practical rather than financial, and they lead to a suboptimal level of diversification.

Overcoming home bias does not require exotic or complex investments. The following practical steps can help investors build appropriate international exposure:

• Start with a target allocation. Decide what percentage of your stock portfolio should be international. A range of 20% to 40% is commonly recommended. Even 20% represents a meaningful improvement in diversification over a purely domestic portfolio.
• Use broad, low-cost index funds. A single total international stock market ETF (such as VXUS or IXUS) provides exposure to thousands of stocks across dozens of countries in one holding. You do not need to select individual countries or regions.
• Automate your contributions. If you invest regularly (through a 401(k), IRA, or brokerage auto-invest plan), set your international fund allocation once and let it run automatically. This removes the temptation to skip international investments when U.S. markets are outperforming.
• Rebalance periodically. When U.S. markets outperform, your domestic allocation will grow and your international allocation will shrink. Rebalancing annually or semi-annually back to your target ensures you maintain your intended international exposure.
• Think long-term. International investing requires patience. There will be extended periods when U.S. markets lead, making international holdings feel like a drag. History shows that these periods are followed by periods of international outperformance. Diversification works precisely because you cannot predict which will happen when.